This article was first published in the Moneyweb Investor. To read the magazine click here.
Net1’s results for 1H16 have been damaged by the rand’s rapid depreciation against the greenback. The group generates most of its income in rands but reports in dollars, so revenue growth looks much weaker.
Further complicating its outlook is the SA Social Security Agency contract to distribute social grants which is set to lapse in 2017. The government has confirmed that it will take over the grants distribution, though there is significant doubt that it will be able to develop the capability to do so in time. The Sassa contract contributed 24% to group revenue in FY15, a smaller percentage than before. We are encouraged by management’s successful efforts to replace the Sassa income, although it is not clear how important the Sassa contract is as a client recruitment mechanism for these alternative sources.
In addition to growing alternate revenue streams in recent years, during FY15 it launched Zazoo (which develops mobile and web-based applications mostly related to money transfer services) and EPE (EasyPay Everywhere – a sort of transactional bank account which give clients access to other financial services such as microloans, life insurance, remittances, and value-added services such as prepaid utilities and bill payments through mobile phones and a national network of ATMs and point-of-sale devices). It also resumed its life insurance business which was temporarily suspended by the Financial Services Board.
Furthermore, during the period several costly litigation issues have fallen away including a Constitutional Court case over the Sassa tender and an investigation by the US Securities Exchange Commission, but one being conducted by the US justice department in terms of the Foreign Corrupt Practices Act is still open.
Net1 UEPS share price (rebased)
The results reflect a deterioration of the currencies in the areas in which Net1 operates – SA and South Korea. The dollar appreciated 23% against the rand and 13% against the South Korean won. Whereas revenue increased by 21% in rands to R4.11 billion, it actually declined 1.9% in dollar terms to $304.8 million. The rand increase in revenue was driven by sales of low-margin prepaid airtime and an increase in transaction fees as well as the launch of Smart Life insurance and EPE. However, cost of sales accelerated 31% (dollars: 7%) due to the costs of launching EPE and Smart Life insurance, so the operating margin fell to 18% from 21%. Depreciation also rose significantly as a result of the rollout of EPE ATMs and the acquisition of more payment terminals in South Korea. The overall effect was a 15.2% decline in headline earnings.
The company faces two major risks. First, whether it will be able to replace its Sassa-related income. Second, whether the US justice department finds evidence for prosecution.
Among its three divisions, the one which houses Zazoo and EPE, financial inclusion and applied technologies, has grown its revenue phenomenally, experiencing a compound annual growth rate (CAGR) of 64% for the past three years. On the other hand, the SA transaction processing division (which includes Sassa) has grown the slowest at a CAGR of 21%. This has seen the waning of Sassa revenue contribution, which fell to 24% in FY15 from 42% in FY13. In addition, the financial inclusion and applied technologies segment generates superior margins.
We like management’s never-say-die attitude. In addition to launching Zazoo and EPE, it has gone into partnerships and acquired substantial stakes in small international companies that operate in similar fields. It has partnered with money transfers agencies: WorldRemit in SA and Oxigen in India. It recently acquired Transact24, a specialist Hong Kong-based payment services company. However, because most of its business is in emerging markets, exchange rate risk is high.
Furthermore, its banking and insurance businesses could temporarily benefit from the endowment effect given that we are in a rate hiking cycle.
With banks under pressure to cut costs and invest less in mortar-and-brick, the growth of mobile and online transaction processing will remain strong. Zazoo’s online- and mobile-based business model is geared towards the financially-excluded by offering a lower-cost and more scalable alternative to traditional banking. We believe Net1 offers distinct growth that is hard to find in most JSE-listed companies given the economic uncertainty facing SA. The share price has depreciated and for the potential growth it offers we think a price:earnings ratio of less than 7 makes it cheap. But in light of the risk factors mentioned above we remain cautious and change our previous sell recommendation to speculative buy.
South African investors should also note the thin liquidity on its SA share registry: less than 1% of its scrip is available to retail investors.
- Potential for massive growth in the mobile- and web-based applications space
- Competitive intellectual property – Zazoo won in the “best fintech innovation category” at the 2015 Apps Africa innovation awards
- Low penetration levels in emerging markets provide scope for growth
- The pending end of the lucrative Sassa contract without hope for renewal
- •Customer concentration is high
- Pending litigation
- Threat of competition from local big banks and international corporations
- Weaker rand translates to lower reported earnings in US dollars
Nature of business: Net1 is a provider of alternative payment systems that leverage its Universal Electronic Payment System (UEPS) to facilitate biometrically secure, real-time electronic transaction processing to unbanked and under-banked populations in an online or offline environment. In addition to payments, UEPS can be used for banking, health-care management, payroll, remittances, voting and identification. It provides payment solution platforms in SA and the Republic of Korea. It also offers financial services and hardware and software sales. Net1 has its primary listing on the US’s Nasdaq index and therefore reports in US dollars. Its secondary listing on the JSE (it generates more than 70% of its business in SA) requires it to report headline earnings per share and it makes an effort to provide rand supplementary information.
Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view.